Episode 17: Howard Marks - Co-Chairman of Oaktree Capital Management

0:01This week, I have the honor of speaking with none other than Howard Marks, legendary investor, bestselling author, and co-founder and co-chairman of Altri Capital Management. the world's largest distressed debt investor with over$180 billion in assets under management. Known for his sharp thinking on risk, cycles, and market psychology, Howard has become one of the most influential voices in global finance. His memos are read by investors all around the world, from retail traders to the heads of central banks. In his books, including The Most Important Thing and Mastering the Market Cycle, are considered essential reading for anyone in markets.

0:37In this episode, we spoke about his career, his philosophy on his investing, and the timeless principles that have guided him in building one of the most respected firms in the industry. I enjoyed this conversation, and I hope you guys enjoy. Thank you. Thank you for joining me, Howard. I really appreciate it, and thank you for making the time. My pleasure to be here, Amir. So I want to start off at your beginnings. So can you give me a little bit of background about your childhood, and were there any experiences during your childhood that you believed shaped the person that you eventually became?

1:10Well, I was born in Queens, New York, middle-class family. My dad was an accountant, and we lived okay. I don't think there were any turning points in that period. It's just that I reflect now on the fact that my parents, having been born in the 1900s, were adults during the depression. And I think that the depression was a very scarring experience and I think it scarred them. And so I ended up hearing things like, don't put all your eggs in one basket and save for a rainy day. And I think that made me a conservative person. And that's it. The rest of it was pretty much by the book. If I talked to a 15-year-old Howard Marks, what would he say you wanted to do when he grew up?

2:03Oh, at 15, I was probably either a history professor or an architect, something like that. Yeah. I want to move on a little bit to your early career because I find that particularly fascinating. So you started at Citi in 1968 and went from an equity research analyst at Citi to eventually senior portfolio manager in charge of the high yield debt and convertible bonds before you left in 1985. You described a stark difference between the two positions. So equity research and then eventually the early days of starting kind of the overseeing high yield and overseeing convertible bonds. What are the differences like between the two positions?

2:53and what was it like being in high yield during the early days? Well, the biggest single difference in the year was not between equities and debt. The biggest difference was that when I was in equity research, I was on an institutional bank bureaucratic career path, from junior analyst to analyst to senior analyst to unit head to director of research. So six years, less than six years after I got to the bank, at the tender age of 29, I was made director of research. And I now realize that. And I used to say that, well, my job was to know two sentences on 400 companies, which is very unsatisfying.

3:43I now view it that my job was a managerial job and not a doing job. And that's what I think I was unhappy with. And, you know, I had this superficial relationship with all these companies. and I didn't know much about how money was made in the market because I had never practiced it. And I studied companies, but studying companies is only a small part of what's required. We were investors in the nifty-fifty. The nifty-fifty did horribly. A new chief investment officer came in. He wanted his own director of research, and I was outplaced to the bond department. Now, in the bond department, I don't have to know two sentences on 400 companies.

4:31I I have to know everything on 30 companies. And I was ecstatic. And that's the difference between managing an organization and doing. And I was happy and I was working in convertible bonds at first, which was an inefficient market niche that most people didn't care about or know about.

4:58and where you could get an advantage through hard work and skill. You can't get an advantage in the large cap equity business, in my opinion, or very few people can. And then I got a call in August of 1978 from the head of the bond department. He said there's some guy named Milken or something out in California. He deals with something called high yield bonds. Do you think you can figure out what that means? Because a client had asked for such a portfolio. And I was smart enough to say yes. And so I started my high yield bond investing in 78. That was essentially the beginning of that world. And as Malcolm Gladwell said in Outliers, it's great to be in at the beginning.

5:44That's demographic luck, which I experienced. So, you know, high-yield bonds provided the cornerstone for most of what Oak Tree does today, and we've evolved from there, but in an organic fashion, and now we do a lot of things related to sub-investment -grade credit. you left city in 1985 and moved on the tcw and in 1988 you started one of the first distressed debt funds um at tcw with bruce karsh who would eventually become one of your partners for starting oak tree what gave you the conviction to start this then me strategy and what was the reaction like at that point in time from your clients your peers and everyone else in the industry?

6:28Well, you know, so at that point, Bruce approached me in 87. At this point, I've been managing high-yield bonds for nine years. And if you do that, you've had some experience. You know, you buy a bond at par or 100. Once in a while, they default and go to 10 or file for bankruptcy. And you go on the creditor's committee, you work on the restructuring, and if you can negotiate well and if your claim is valuable, you might end up getting 30. So, you know, when Bruce had this idea, it appealed to me immediately because what if you could skip the 100 to 10 part and just do the 10 to 30 part? And so, you know, I hired him and we became partners.

7:27And, you know, I helped him raise his first fund. It was very controversial. You know, when I started in high yield bonds, people said, what, are you crazy? You're going to lend money to companies that are rated single B? But then when we started Bruce's fund, they said, what, are you really crazy? Now you're going to buy the debt of companies that are bankrupt or destined to become bankrupt? How can that be smart? And so I helped him raise that money. And his first fund raised in October 88 was$65 million. Then we had a second closing when we got it up to 96. And we thought that was a lot of money.

8:12and so but we had to you know in both cases we had to row uphill and it was hard lifting and we couldn't raise much money but the main rule in investing is that if you are willing to do things that nobody else is you might get a bargain and we did and you know that first fund had a very nice return and got us off to a great start. And Bruce, when we started, you know, Bruce was my junior partner employee at TCW, but when we started Oak Tree 30 years ago, we became co-equals and we still are. And it's a great and rewarding partnership. During those times starting high yield and then being early in the stress debt, how did you maintain conviction when those strategies weren't mainstream yet?

9:14I would say two ways, Amir. Number one,

9:20you know, people say, oh, it's great, it's safe, that's good. Or it's risky, that's bad. And those are like broad brush statements that are kind of irrelevant. Now, the nifty 50 were considered to be such great companies, the best and fastest growing companies in America, where nothing bad could ever happen and there was no price too high. And if you bought those stocks, the day I started work in September of 69, and if you held those stocks tenaciously for five years, you lost about 95 % of your money. So obviously buying high quality assets is not the key. And I reached the conclusion that success in investing doesn't come from buying good things, but from buying things well.

10:04And that there are no assets which are so good that they can't become overpriced and dangerous. And there are very few things that are so bad that they can't be cheap enough to be attractive. And that's really, so I just grasp, maybe it was a result of my nifty 50 experience, but I grasped the fact that sure, high yield bonds and then later distressed debt weren't great credits, but if you buy them cheap enough, it's worth doing. And that's the way it turned out. The other thing is, people say, oh, you could have defaults in high yield bonds, so you shouldn't do it. You have to quantify these factors.

10:46The mere fact that you could have a default itself is not crippling. In 81, a news network asked me, how can you buy high yield bonds when you know where some are going to default? And I said to the reporter, most conservative companies in America are the life insurance companies. How can they insure people's lives when they know they're all going to die? Same thing. And the answer is you can take risk intelligently if you think about it, if you can quantify it, if you can diversify it, and if you're well paid. And that's what we've done now for 47 years with success. So, you know, the life insurance company doesn't sell insurance policies without expecting people to die.

11:37they build that into their thinking. So when you invest in low quality bonds, you assume that you'll have some defaults and you compute the impact relative to the compensation you receive for bearing the risk. And it's not good or bad, in or out. It's, is it risky? How risky? What's the The expected return isn't sufficient to compensate. And so, you know, I set up numerical tools to do that. You left managing$7 billion with Bruce Karsh at TCW, which still is a lot of money, but at that time was a humongous amount of money, to start Oak Tree from the grant level. Why did you leave to start Oak Tree?

12:33and I'd love for you to describe the early days, kind of like the building days, what it was like at that time. Well, you know, TCW had 50 different strategies that ran 50 different ways. And we had a few strategies which all ran the same way and we considered that to be our way and the right way for us. And we wanted to be in an organization that only did a few things our way.

13:04And Bruce and I and the three other founders of Oak Tree, at that point, 95, had worked together for an average of nine years. So we knew we liked each other. We liked working together. We knew we shared values and respected each other's ability. So we knew we could have a pleasant, harmonious experience.

13:29and then there were the normal reasons to leave. The boss at TCW was a little capricious and he liked to push you around a little bit, which wasn't great. And when we started making a lot of money through the carried interest on our distressed debt fund and related funds, and they wanted a certain percentage of that, which we felt they weren't doing anything to create, that became, I would say, the impetus for leaving. And so, you know, when we had$7 billion at TCW, by the end of the first nine months, we had brought over$5 billion of that to Oaktree. So, you know, I think the clients also viewed that we had done a good job performing at a TCW and there's no reason we shouldn't do less well for them.

14:24at Oak Tree. What do you see as the key moments or turning points that led to what Oak Tree is today? Were there any specific moments that you think really made it take off or something along those lines? No, it wasn't that kind of thing. It wasn't like there was a big bang moment that made us successful. We just continued to practice the skills we had practiced at TCW. We continued to have good, steady results. Bruce's, you know, results were exceptional. You know, we started Oak Tree in 95 and, you know, we had, there was a crisis in one that we did a good job in and so forth. But it wasn't, you know, there wasn't a turning point or an inflection point.

15:20But if you want to look at a moment, I think the most important thing was that we had the tech bubble, internet bubble of 98, 99, early 2000. And then it burst in mid 2000. And the stock market, the S &P was down in 2000 and in 2001 and 2002. So that was the first three-year decline of the S &P since the Great Depression, 1939. And so people kind of fell out of love with the stock market. The Fed cut interest rates to combat the recession that was taking place. And interest rates were so low that they fell out of love with bonds. And so they needed something. First, they tried hedge funds, and then they tried private equity.

16:11And these things developed the following. And from that moment, let's say, oh, four, five, six, the area called alternative investing was born. There was no name alternative investing before that. It was a name that was arrived at to describe things other than stocks and bonds. And, and so everybody in 05 says, hey, let's do something called alternative investing. And guess what? We were there. We hadn't, we never said, you know, in 95, we didn't say in 05, everybody's going to start to want, going to want to start into, into, into the things we do. We just did our thing and it turned out to be a destination.

17:01That's the second example. And I've had many, Amir. That's our second example of what Gladwell calls demographic luck. Right time, right place. We were in a place. We didn't pick the place based on a projection. We were in a place and it turned out to be the good place. And that really, you know, that's why, you know, we had five billion when we started at Oak Creek, we might have had, I don't know, $25 billion,$3,$4,$5 or something like that. But then people decided to pursue this thing called alternative investing. And that's why we have$200 today. What makes a great investor? What are some characteristics that make a great investor?

17:54Well, first of all, of course, you have to be numerate and analytical. Beyond that, great investors come in all shapes and sizes. Some are colorful, some are plain, Some are conservative, some are aggressive.

18:19I think that some are emotional, some are placid.

18:26But what it comes down to is

18:35a special insight. The ability to look at an investment and understand its potential and understand the probability that the potential will be achieved and understand the risk of failure and put those things together into an equation. It doesn't have to be a mathematical equation where you can conclude that the upside potential more than merits taking the downside risk. That's what it all comes down to. Now, you can be a conservative person and do that with high-yield bonds. You can be an aggressive person and do it in the venture capital business or with rapid growth stocks. But no matter what your personality is and no matter what your predilection is as to behavior, I think you're not going to be a successful investor if you can't figure out which things there are where the upside more than compensates for the downside.

19:41In short, in short, you know, the way I describe it, I describe investment performance as like there's a bag and has a bunch of balls inside the bag, like lottery balls. And fate reaches into the bag and pulls out a ball. the balls in the bag are all the possible outcomes the one that's pulled out is the actual outcome you pull one fate pulls one outcome from a range of many possibilities if you get a black ball that's good if you get a white ball that's bad a black ball is a winner a white ball is a loser

20:23and yet you don't know which ball fate is going to pick I think that the way I think about it is that the superior investor has a better sense than others for the balls in the bag. The better, you know, through some analytical process or just thinking about it or some insight, But the superior investor knows when there's 75 % black and 25 % white and it's worth playing. And when it's 25 % black and 75 % white and it's not a good idea to play. I think that's what it's all about. You bought some of the greatest companies in America, as you previously described, through the nifty-fifty when working at Citi.

21:16and lost money on a lot of them. You describe Oak Tree as buying the worst public companies in the United States, but for great prices. When does price matter? Always. Price always matters. As I said a couple of minutes ago, there's nothing so good that you can buy it without price. And these are the lessons that I learned in my first decade. And you only learn from success, from failure. You don't learn anything from success. and hopefully when you experience unsuccess, you look back and you try to figure out why. And what was the problem with the nifty 50? The problem was some of them were great companies.

21:58Maybe most were great companies, but who came up with this idea that it didn't matter what price you paid? Which was really, I would say that was the official dictum. And so now I don't think anybody buys without regard to price. The world has gotten a little smarter. Most people have the same data when it comes to investments. But what makes great investors is extracting the importance from that data and understanding the qualitative factors. When narratives and statistics, the data diverge, which ones do you primarily, which one do you primarily listen to?

22:45Well, as you say, everybody has the same data. You have to go above and beyond the data to insight. You have to, you know, my son, Andrew, who's this great venture capitalist. when we lived together during the pandemic, when we discussed investing ad nauseum and debated value investing versus growth investing, you know, he made the point that

23:16readily available quantitative information about the present cannot make you a success because success comes from outperforming and everybody has the same data. So merely possessing the data can't make you a success. To be a superior investor, you have to either do a superior job of understanding the implications of the data, what's going on at the company that you see that others don't, or understanding the qualitative factors surrounding the company, the quality of management, the quality of the product pipeline, the quality of the research effort, or what have you, or understanding potential future.

24:05In other words, you have to do a superior job

24:14of assessing information that is not readily available and quantitative.

24:25Yeah. You, I want to move a little bit on to kind of, I've asked this to a couple of people who've had successful partnerships, and I'm very interested in a specific topic. You and Bruce Karsh together have built one of the largest alternative asset managers in the world. What makes a great partnership and what's your relationship like with Bruce? Well, it is a great relationship. It's one of the greatest things in my life. You know, after my family and some of my friends, my work experience and especially my partnership with Bruce is paramount. And, you know, I wrote a book in 2011 called The Most Important Thing.

25:12It was based on a memo that I wrote around 2002 called The Most Important Thing. And what they both had in common is that in every chapter of the book and every section of the memo, it starts off the most important thing is, and then it's a different thing. Because there are so many things that are important. You can't just say one. But in the memo, I didn't put it in the book because it's not about investing. But in the memo, I said, I talked about the importance of having a great organization. And I talked about what makes a partnership great. And what I said there was shared values and complementary skills.

25:52I can't imagine being partners with somebody where I have a difference of opinion over value. I'm conservative. He's a wild man. We're going to have a big problem coexisting because I'm going to hold him back when things go well and he's going to get me killed when things go poorly. I have integrity and he doesn't. So I'm going to it's going to kill me every day to see him cutting corners. So it's really, in my opinion, not a good idea to partner with somebody, whether it be in business and domestically or friendship, where you don't share values. On the other hand, you should have different skills and they should be complementary.

26:36I've seen lots of partnerships fall apart because one guy says, I can do everything he can do and everything I can do. What do I need him for? And so, you know, the beautiful thing about the relationship with Bruce is that we have different skills that complement each other and different styles, even. I mean, Danny Kahneman wrote that great book, Thinking Fast and Slow, about behavior. Now, I happen to think and he thinks we have both and they come together. But I think that for the most part, I am a fast thinker and Bruce is a slow thinker. and I reach quick conclusions based on impression. And then I'm mostly done.